Tip Jar

The danger next time: the pressures to keep financial instruments unregulated

Diane Rehm Show, October 22 2009. "A look back at the secretive, multi-trillion dollar U-S shadow banking
system. Understanding the role unregulated derivatives played in the
economic meltdown last year, and why some say the same risks remain
unchecked today."

___

Panel:

Greg Ip, U.S. economics editor, "The Economist"

Michael Greenberger,
professor, University of Maryland Law School, director, Center for
Health and Homeland Security, and former senior regulator, Commodities
Futures Trading Commission

Martin Baily, is senior
fellow in economic studies at Brookings Institution, former chair of
the Council of Economic Advisors during the Clinton administration
(1999-2001).

____

Diane Rehm: One year ago the world appeared to be on the verge of the second Great Depression. Some analysts believe the crisis could have been averted -- or at least lessened -- by heeding the warnings of the Commodities Futures Trading Commission. That agency was concerned about a growing market that lacked transparency and was mostly unregulated. Joining me to talk about the rise of the secretive, multi-trillion-dollar derivatives market and its role in the financial crisis -- and what's being done to prevent another meltdown -- are former CFTC senior regulator, Michael Greenberger; former chair of the Council of Economic Advisors during the Clinton administration, Martin Baily; and Greg Ip, US economics editor for the "Economist". ... We'll try to bring clarification to a very complex issue. ...Michael Greenberger, take a crack in as simple terms as possible at explaining what a derivative is.

Michael Greenberger: The most classic derivative and the way derivatives got started was farmers who wanted to buy insurance products so that when they planted seed, by the time the harvest occurre they would have locked in a price that would guarantee them some form of profit. If the real market didn't give them their profit they could shift over to the so-called "futures market". If the real market gave them a profit they could get out of their so-called "insurance contract." Technically these are called futures contracts. The value of that insurance is completely dependent on whether it's going to be used. In other words, if prices are going against the farmer, the insurance product becomes valuable. It's marketable. He can sell it to someone else if they want it. So the rule -- up to December of 2000 -- was that any contract of that nature had to be traded on a fully transparent, regulated exchange with capital adequacy, anti-fraud and anti-manipulation. In the '80's and the 90's, the banks -- we call them "swaps dealers" now -- developed the instrument called the swap. Simply put in its most classic and benign sense: if you take out a mortgage on your house that has an adjustable rate, you could go to a bank and for a fee they will pay the adjustable rate and they will negotiate a fixed rate for you. So say you've got a mortgage at 6% and you think interest rates are going to go up and you may have to pay 7 or 8 or 9%, you go to the bank and the bank undertakes the obligation to pay the increase and you pay them a fixed rate. Now, they do that at a very [inaudible) cost, and if they feel they're at risk they go and buy themselves an insurance product to lay their risk off. That market was deemed, just by the say-so, as being absolutely the kind of market that should have been regulated. The bank says it wasn't.

DR: Grep Ip -- do you want to add to that definition?

Greg Ip: Well, a derivative is basically a contract. It's value is derived from something else such as a currency, an interest rate, the price of corn. As Michael was saying, the first derivative was quite straight-forward. A farmer wanted to lock in the price of his harvest so he buys a contract to sell his corn 9 months hence. Financial innovation and cleverness being what it is, we now have countless types of derivatives. In the current context the one that most people are now quite worried about is something called a "credit derivative" which is essentially a contract that allows me to lend money, say, to Michael and then buy insurance from Martin in case Michael fails to pay me back. This sounds like a sensible idea. A bank makes a loan, it wants a little bit of protection. But it kind of got out of hand. At the height of the bubble in 2007 the amount of the notional value (if you will) of these contracts was $60 trillion. A lot of that money was not designed to provide legitimate lenders with protection. A lot of it was actually people taking speculative positions. We now know a lot of those derivatives were entered into by firms like AIG -- American International Group -- that had virtually no oversight from bank regulators. When the crisis broke, we discovered that they had offered to pay this type of insurance on those toxic, subprime mortgages that we heard so much about. Their inability to make good on that insurance is why they almost failed.

DR: ... Martin Baily, are derivatives inherently bad? Or inherently good? And depending on how they're managed they get off track?

Martin Baily: I think derivatives are essential to the working of our modern economy. They're absolutely necessary for companies -- particularly those trading around the world. They play an enormous role in allowing people to concentrate on that part of business that they know about and are good at and pass off some of the risk -- whether exchange rate risk or interest rate risk -- to other people. So I think they're really an essential part of our modern economy. They may even have gotten a bit of a bad rap in this crisis. I agree with Greg that it was these credit default swaps -- particularly those that were concentrated in AIG -- that got us into trouble. Normally when you have a derivative there's a swap so there's somebody on one side or the other. That can be very helpful for international trade, for example. If someone in the US wants to trade to Germany, someone in Germany wants to trade in the US, they can both eliminate some of the risk of the exchange rate, change that otherwise might get in the way of that. What happened here was that certain... that the class of derivatives -- credit default swap derivatives -- were issued in huge numbers by AIG and a few other entities. There was really no capital, no collateral, put up against them because nobody believed that the price of housing was going to fall and that we were going to get into this kind of trouble. So my answer would be that they're not only good, they're essential but we do need to make sure that we don't get into the same trouble we got into this time around.

DR: Of course, you were on the Council of Economic Advisers in the 1990's. Were derivatives then something that regulators worried about?

MB: They worried about them, but I think that there were mistakes made. It wasn't just the administration. It was also the Federal Reserve that decided there was no need to regulate these derivatives at all. I think that was a mistake. I think the main regulation that's needed, probably, is to provide information about derivatives. If markets had known that these huge pools of credit default swaps were out there, markets would have reacted and I don't think we would have had quite the same trouble. But I think there were mistakes made in the '90's in not providing enough information about derivatives and not regulating them adequately.

DR: Are you saying that had there been sufficient regulation we might not have seen a crisis as huge as we've had?

MB: Well, I think there were a lot of causes for this crisis. The underlying cause is that all around the world the risk premium fell and no one was taking risks as seriously as they should have. So this crisis might have manifested itself in a different way. If we'd had better regulation of derivatives, I think it would have helped. We would have had a smaller crisis. But I think there were a lot of ingredients that went into this crisis.

DR: ... I want to go back over the history of this whole process a little bit because it seems to me that unless we understand what happened, it could in fact happen again. Michael Greenberger: I want to ask you about Brooksley Born -- who she is and what role she played in this crisis.

MG: To put this in context, Brooksley Born, by the time she became the chair of the FTC in 1996, was a legend among lawyers in the DC bar and, for that matter, nationwide. Had she chosen, she could have been president of the ABA and/or president of the DC bar. She was an excellent litigator who specialized in derivatives. But, I think, more important is that she had a national reputation as someone who fought causes for the public interest -- women's rights, consumer rights, environmental rights. She was very seriously considered to be Clinton's choice for attorney general because of a long-standing friendship through American Bar Association activities with Hillary Clinton. She did not get that job. But she did become the chair of the CFTC. I would just say, with regard to my fellow commentators here, I agree with them in spirit. I disagree in tone about the dangers of these products. Brooksley in 1998 tried to get the Clinton administration and Alan Greenspan to do something about what she saw as a danger to the economy. ...She came into office in 1996 as chair of the CFTC. By that time, Orange County had gone bankrupt. Today we're so used to bankruptcies that it doesn't sound very dramatic. But at the time it was shocking that a county would go bankrupt because they misunderstood their use of unregulated derivative products. There was a major scandal on Wall Street where Bankers' Trust was claimed by Procter Gamble to have defrauded them, knowing they were doing so. Their case was supported by tapes with the Bankers' Trust traders laughing up their sleeves at how they took Procter Gamble to the cleaners. There was uniform concern. At one point Congress -- because of these events -- wanted to do something aggressive about it. The GAO recommended that something aggressive be done about it. Brooksley viewed what was then somewhere between a $13 trillion and $27 trillion market. By the way, in world-wide notional value it's now $592 trillion -- 13 times the size of our annual GDP. But she foresaw exactly what was going to happen. These were unregulated markets. Nobody was getting information about them. None of the commitments -- like the commitments AIG made, $400 billion -- were backed by capital. There was no anti-fraud protection, no anti-manipulation.

DR: And she attempted to bring all this to the attention of Alan Greenspan -- and others!

MG: She wanted to issue a white paper to be commented on so information could be collected. She wasn't even proposing a regulatory scheme. Long story short: in a very violent meeting chaired by Secretary Rubin and attended by Alan Greenspan and Arthur Levitt ...

DR: ... and Larry Summers?

MG: And Larry Summers. By the way, Arthur Levitt has since recanted his involvement in this. They in very tough terms told her that if she did this (they didn't use these words but the message was) this would be the end of her. She did it. Phil Gramm and many others hounded her for months and months. At the behest of Bob Rubin, Alan Greenspan and Arthur Levitt. They issued a statement the day she issued the white paper. They asked Congress to stop her from doing anything about this. Congress almost unanimously agreed to do so.

DR: Greg Ip: what else was going on?

Greg Ip: Let me mention a name we almost never hear about any longer. Enron Corporation in the late 1990's had ambitions to be a major player in the trading of energy derivatives. If Enron had been required to do all those trades through highly regulated exchanges, its business would have been far less profitable. So they had a very powerful interest in not seeing Brooksley Born's proposal that things be regulated and see the light of day. So they had a very formidable lobbying operation in Washington that they brought to bear on this. A few years after Brooksley Born had left the CFTC Phil Gramm, the Republican chairman of the Senate Banking Committee steered through Congress an overhaul of our commodity laws which passed during the lame duck session in 2000. It basically once and for all said, "These swaps can no longer be regulated by the CFTC." I do want to add one thing. There were two major reasons why the banks, Enron, Greenspan and Rubin and Summers opposed this. One was a parochial, self-interested reason: the banks made a lot of money by trading these things in their own trading room instead of on transparent exchanges. But the other was that for years these swaps had been growing in a legal no-man's-land. It had never been made quite clear whether these things were just one-to-one contracts -- which you could do any way you wanted -- or that these were actually futures, just like those that had been traded on corn and oil for decades. If they were futures then by law they had to adhere to CFTC's rules. The thing that Rubin, Summers, and Greenspan kept emphasizing was that Brooksley Born was casting a pall of legal uncertainty over these things. Gosh, if this thing went through, all the people who had entered into these contracts would suddenly walk away from them. They would think, "They're illegal"! And they though that would bring the financial system down. Almost certainly those threats were exaggerated. But it was a legitimate thing to worry about.

MG: I just have to intervene at this point! That is a fallacy about what Brooksley did. In the white paper it said -- in bold terms -- anything the CFTC did would be prospective only. It had the power to amend prospectively. The word "prospectively" was used in terms. The banks -- and I don't just blame Enron for this -- I blame Goldman Sachs, Morgan Stanley, Merrill Lynch, AIG. As Larry Summers said when he berated Brooksley for doing it, "I have 13 bankers in my office who say you're going to cause the worse crisis since World War II. The banks kept saying, "Oh, she's going to undo the old market." And she kept saying, "No, I'm talking about the future."

DR: Martin Baily, were you privy to any of these conversations?

MB: I was not part of the conversations or a part of the decision not to regulate derivatives. As I said earlier, I think that was a decision that was a mistake. I think they should have allowed more control over derivatives. I do think that the discussion we're getting into has that slightly exaggerated sense of a) how important the derivatives were to the crisis that we're in. This notion of the value of the derivatives is, I think, relatively meaningless in terms of the size of the crisis. Most of this crisis has come because of mortage defaults and defaults on other kinds of assets. I might also say that simply regulating something doesn't guarantee that you're going to get a good outcome. We had rooms full of regulators in the banks. We had rooms full of regulators at Citibank. That didn't stop them from going down. As a matter of fact, the Office of Thrift Supervision knew perfectly well that AIG was issuing all these derivatives and they didn't do anything about it. So a big part of what we've seen is actually fairly by-the-regulators themselves to keep control of the system, not just a lack of regulation.

DR: However, you heard Michael Greenberger talk about the fact that derivatives are now at something like a $500 trillion level -- still without the kind of regulation that Brooksley Born was calling for going forward. Are you not at all concerned that the same problem could rise again?

MB: I think Brooksley Born was a hero and I had the opportunity to testify in front of the commission that's been appointed to look at the causes of the crisis and she's a member of that commission. I don't want to overstate my disagreement with what's been said here. The fact that there are $500 trillion in derivatives outstanding in and of itself does not worry me.

DR: Why not?

MB: Well,why would it? These things are financial assets that are used for ... we have a very large global economy and these things are playing an important role in that. Just throwing out that number, I think ...

MG: ...Diane, I really have to say something here. Let's just look at AIG. With $200 billion in equity, one of their many subsidiaries guaranteed the investments in subprime mortgages. They set a floor through insurance. They issued $400 billion in insurance without a single penny put aside for capital. Because, as Martin said, they thought housing prices would always go up and this would never be a problem. You and Greg and Martin and I have bailed AIG out. They didn't have the money for the insurance. Now, by the way, who got the money? The money went to AIG through the front door and out the back door it went to Goldman Sachs and thirteen of the world's largest banks who bet -- who bet -- that people would not be able to pay their mortages!

GI: I just want to make a small explanation ... about where this $500 trillion figure comes from. Imagine that I have a house that's worth $100,000 and I promise to pay you 1% of the value of the house at the end of the year -- $1,000. The way we measure the value of that contract is the value of the house -- $100,000. But that $100,000 is not actually at risk because I'm not going to lose my house. The $1,000 is what's at risk. So the $500 trillion figure here is what we call the "notional value." But the actual amount of the value at risk is quite a bit smaller. However, the numbers are still quite large and the intrinsic nature of derivatives is that they allow considerable amounts of leverage. Which is to say that the amount of money at risk can change quite a lot it a very short period of time given how the underlying thing that you're basing the contract on changes.

MB: If you had allowed me to finish my earlier sentence -- thank you, Greg -- because that explains why this $500 trillion is an inflated number. I think it clearly was wrong that AIG could issue these derivatives without capital and it is being proposed by the administration that capital requirements be applied to these derivatives now and that is something I support.

DR: Why has it taken so long? That's the question. Considering that this meltdown first began to occur a year ago and Brooksley Born was talking about this years before that, why is it taking so long, Greg?

GI: Well,you know, because we passed the law in 2000 and actually shut the whole discussion down. We basically had to restart the entire process over again. You could actually say that, given that AIG was one year ago, we're actually moving at considerable speed. The last regulatory reform we had in this country was ten years in the works. But I think the question you're asking is, "Why hasn't anything happened yet?" We have actually got some things happening. Last week, Barney Frank, chairman of the House Financial Services Committee, did pass a bill that incorporates a lot of the changes that Brooksley Born called for ten years ago. To be sure, there are some important exceptions. There's a vigorous debate going on right now whether those exceptions significantly weaken the regulation of derivatives that we should have.

DR: Brooksley Born was the subject of a Frontline piece that aired just the other night. We invited her on the program but this morning she was flying to San Francisco. We hope to hear from her at a later date. ...I'm going to open the phones to callers.

Tom: I've been in the wealth management business for about ten years. I'm a registered principal. I find all this extremely fascinating. I once held in my hand a futures contract written on a cuneiform tablet from thousands of years ago -- from what was then [inaudible]. The challenge that we have is that 1) the wealth management companies, since the market dropped, have been firing their compliance departments and making do with fewer compliance officers to oversee transactions. And the other was just brought up: a person with, say, $5 buy $100 worth of futures contracts which means that if the futures contract goes down 5%, he no longer has any money. He's going to be called on a rent fee. The rent fee on stocks is if you have $2 you can buy $1 worth of stock without selling anything, without having additional cash. You can see that this can easily get out of hand, especially when the regulators are understaffed, [inaudible] is understaffed, and now the Wall Street banks' wealth managers are understaffed. So this very easily gets out of hand.

GI: It comes as a surprise that wealth management companies are firing compliance people. The evidence was the opposite, so that's very worrisome. But let's talk a little about how risk the situation is going forward. We've seen companies like Morgan Stanley and Goldman Sachs report their earnings in the last week or so and what you discover is that they're still making a huge amount of their money by trading things. So it's a legitimate thing to say: are things just as risky? My own view is that they're probably not. Because of the trauma inflicted by the last year or two, the riskiest of these derivatives have been flushed out of the system. In fact, the latest data do tell us that the amount outstanding of these dangerous credit derivatives has fallen roughly by half. But I think that there are problems waiting in the wings and they come from a couple of sources. The first is that the government has essentially put its guarantee behind our financial system. They felt they had to do that to stop it from melting down. But what that means is that all of the companies that are explicitly or implicitly covered by that guarantee -- whether it's your community bank or Goldman Sachs -- are now able to borrow excessively cheaply because all their lenders think, "Well, if Goldman Sachs goes down, the government will bail me out!" That is a license for them to take excessive risk. We still do not have the regulatory mechanism in place to suppress that risk-taking. The other thing that I just wanted to mention here is that the essence of the change to the laws that we're going to have on derivatives is that we're going to centralize this trading on exchanges -- much as we trade stocks on the New York Stock Exchange. These swaps will now be traded through something like the Chicago Mercantile Exchange or the New York Mercantile Exchange. Sounds like a good idea, right? Instead of Goldman Sachs trading with Bank of America, Goldman Sachs will trade with the Exchange and Bank of America will trade with the Exchange! Why is that a good thing? Well, if Goldman Sachs goes down, instead of being a problem for Bank of America, that'll be a problem for the Exchange. Hopefully, the Exchange will have lots and lots of capital and collateral and it won't be a problem. But it's entirely possible that the opposite will happen, that so much risk will become concentrated in just one place that the failure of one big firm -- like a Goldman Sachs -- could bring the entire system down.

DR: Are you concerned about that as well, Martin Baily?

MB: Yes... I think we have to make sure these exchanges or clearing houses have an adequate amount of capital to deal with the situation. I think it actually would be a mistake to require that all derivatives be traded on exchanges because there's also a role for customized derivatives that are not on exchanges.

DR: Michael Greenberger, I want to ask you about Larry Summers' role in the failure of that derivatives market -- if we can call it a crisis. Does he concern you as the director of the president's National Economic Council?

MG: Let me say, as I said in the Frontline piece (and Brooksley does not want to comment on the record), he was extremely rough with her in trying to convince her not to go forward -- shouting at her and using what I would call bullying tactics. That having been said, the Obama administration put out a white paper in June that satisfied me and many other reformers because it said all these products essentially -- save a few -- have to be traded on exchange. When the administration sent its legislation up, it said "except if it deals with foreign currency" -- which is what brought down one of the biggest hedge funds -- or "except if a non-banker is a counter-party" -- which means everybody else except banks. On August 17, Gary Gensler -- who by the way was a Summers and Rubin protege in the Clinton administration and is now the chair of the CFTC and former Goldman partner -- wrote a letter and said, "These are exceptions that swallow the rule." So on the one hand -- and this is what is happening today -- people are saying, "we're fixing it." But when you read the details, there are exceptions that swallow the rule. That's true of the Obama administration. It is even more true of the financial services legislation that went out last week. It is even more true of the Ag Committee's reports yesterday. When we say, "Will exchange trading work?", my compadres in this -- the unions, the environmentalists, the consumer groups, Consumer Federation of America, investor protection groups -- they believe that the law will end up being worse than the law that was passed in 2000 which Brooksley Born complained about.

MB: I think Gary Gensler is right to warn against the dilution of the regulation. At the same time I think some of the efforts are being made to sort of throttle financial markets altogether, and I don't think that's the right answer. We need a financial system that is robust but we can't expect that companies will never go down or that failures will never occur. We just want to have in place institutions which will allow those failures to occur without bringing down the whole economy. So success and failure are part of our financial system and I don't think we should over-regulate it so we always prevent these things from happening.

GI: The people who advocate these exceptions -- there is a point to what they're saying. Financial contracts come in a wide variety of types and sizes. The case for trading like the stock of International Business Machines on a stock exchange is cut and dried. IBM has billions of shares and each share is exactly like the other one. Hundreds and millions of them trade every day. So everybody who goes to buy or sell a share of IBM -- they know what they're getting. But when you get down to some of these derivatives contracts, they get pretty obscure and pretty tailored to the needs of a particular company. I need to borrow euros and swap them into yen for exactly 93 days for exactly this amount of money. It's very hard to find people with exactly the same needs. Therefore, if all those types of contracts must be traded on an exchange, there would be no volume and that could actually drive up the prices. The trick for the regulators now is what the dividing line is. Because you can be quite certain that those who want to trade things out of the oversight of regulators -- because it's more profitable, for example -- will look for exceptions and try to exploit them. That's more or less how we got AIG. AIG traded these products through a non-bank subsidiary precisely to avoid the higher costs and tougher oversight of some of its regulators.

MG: Absolutely correct! Goldman Sachs made a decision over the summer of 2007 that the subprime mortgages would fail. It wasn't just AIG. They went to Lehmann and Bear Stearns and said, "We want the insurance." The insurers never asked, "Are you holding any of the instruments?" In other words, it's like insurance somebody else's house knowing it's going to be set on fire. The money that went to AIG -- which is your money and all of us here -- went in the front door and out the back door. Not $12 billion but $13 billion to Goldman Sachs whose CEO was in the meeting in September 16th deciding whether AIG would be saved by the American taxpayer. If the American taxpayer -- who does not come up in any of these discussions -- were worried about Exxon Mobil and Cargill and whether they're going to have to pay for regulation, the American taxpayer is not represented in this fight. Brooksley Born believes and I believe that if we don't get true, meaningful regulation, we going to go through this cycle again. And every time it comes back, it's worse.

MB: Come on! We were in the middle of a financial crisis. The decision was made that when AIG went down the people who had purchased the insurance contracts would be paid off 100%. With the benefit of hindsight, I think that was probably a mistake. They should have been given what we call a "haircut." That is to say, not paid off every dollar but paid part of what they were owed. Now, remember that folks like Tim Geithner and Ben Bernanke were dealing with a financial crisis which is having a massive effect on taxpayers and on people and their jobs, and they were trying in an extremely stressful situation to make sure that our financial system and our economy did not collapse. They didn't make every decision right. But I would point out to you that the economy is recovering, the financial sector is recovering, so they did it right!

DR: We have a call from Grand Rapids, Michigan, where the unemployment rate stands at 15%.

William: ... I want to know how $17 trillion's worth of mortgages can be insured for $60 trillion.

DR: I'm not sure I understand.

MB: People bought the insurance who didn't own any stake in the mortgages. Three to eight times the number of insurance to somebody who had exposure to subprime loan were bought by people who said, "These people are never going to pay their mortgages! I'm going to take a bet!" In insurance law you can't buy insurance on someone else's life, car, property, home, but AIG was selling it to anybody who wanted it. And we still don't know whether Goldman was exposed to risk or just made a bet. And we paid the bet off 100-cents-on-the-dollar.

DR: Call from Scott in Mayfield Heights, Ohio.

Scott: ... I'd like to look a little bit at how we got here. Can you guys comment on two questions? Senator Phil Gramm put in a Commodity Futures Modernization Act that basically had an explosion of unregulated securities that created the cds in 2000. And then we had -- I believe it was Christopher Cox who was head of the SEC. Instead of having a 1:10 leverage, we went to 1:40 leverage. Can you comment on these two things?

GI: Even though this show has been about derivatives and it's appropriate to discuss the role they had in aggravating the crisis, I think I agree with Martin that they aren't really the prime suspects. In fact, I'm not sure what the prime suspect is. It's like "Murder On The Orient Express": everybody did it. Who do we blame? The successive Democratic and Republican administrations that pushed the industry and everyone involved in housing to get everyone to own their own home? Do we blame the Federal Reserve for keeping interest rates too low? Do we blame the subprime mortgages? Do we blame the derivatives that were written on the subprime mortgages?

DR: Greg, are you saying there are too many people to blame so you can't blame anybody?

GI: It's society's fault!

DR: No! I mean, yes, yes indeed!

MG: People invested in these risky investments because they thought they had insurance. Talk to George Soros. He will tell you. The thought that you had insurance that wasn't capitalized in the end would allow you to invest in the proposition that people who didn't have adequate credit would pay their mortgages. There were many, many abuses. But the faulty, phony insurance was, in my view and I think in many people's view, the engine that [inaudible].

DR: A call from Sycamore, Illinois.

Bob: Congress failed us in the Clinton administration. Congress failed us when they let the bankers that caused this hand out the TARP money with no conditions. The bankers are making money but they're not making loans for this economy to recover. And I'm hearing that AIG, even though it has been saved, will never pay back the TARP money. It's time to elect no incumbents! So the strong message to Congress is to listen to their constituents, not to the corporations and their lobbyists with the slush funds.

DR: It's going to take a long time to get there, isn't it! Martin Baily?

MB: There is some truth in what's said. Lobbyists have too much power and maybe some large corporations have too much power. But I don't think we should get carried away with the populist view that that's all that's responsible. Remember, a lot of individuals who borrowed money on their houses didn't always tell the truth about their financial situation. They borrowed too much and so, as Greg said, I think a lot of people were responsible. One thing I will say, though, in agreement with what my colleagues have been saying. There was an atmosphere that developed starting in the 1970's and went all the way through that somehow deregulation was going to solve everything. It applied to airlines, to electricity, to the financial sector. I think , in many cases, deregulation was a good thing. But I think in some of these cases we went way too far into deregulation. We have to step back and review what we need.

DR: But, according to Michael Greenberger, it sounds as though what's being considered in the way of new regulation may, in fact, miss central portions of what's needed to curb this result.

MB: Well, I don't think so. I think there is going to be significant encouragement to move these derivatives onto exchanges. And if you don't trade on an exchange, you're going to have to have a higher capital requirement. So there will be a financial incentive to put these derivatives onto exchanges. And I think that's probably the right way to go about it. I don't think we should over-regulate this market.

GI: Diane, I don't know what the next crisis is going to be. But I'm pretty sure it's not going to be credit derivatives. It's just the nature of crises and our response to them that we end up putting up all sorts of regulations and solutions to the crisis we've just had and we have a fundamental failure of imagination to think about where the next one is going to be. Now, one of the elements that draws what we're talking about together -- whether it's mortgages or derivatives -- is that it's the nature of our dynamic, capitalist, wealth-seeking society to always try to find a new, clever way to product a new product, whether it's an iPod, a drug, or a derivative. So wherever the exceptions are, that is -- I guarantee -- where the innovation and risk taking is going to flourish.

DR: Okay. What bothers me is that the people who are able to envision what the risks are for these kinds of new things -- new problems -- won't be listened to.

MG: Well, if I can add to that, they're not being listened to today. These callers call up and they're justifiably angry. I can tell you there are five bank lobbyists for every member of Congress who are working on these so-called re-regulatory bills. The device that is being used is to say as a general matter things will be regulated so "don't bother to read the fine print." There aren't enough average people whose voices are being heard. The voices that are being heard are those of the banks, and they have got their customers (in other words, the Chamber of Commerce, the Business Council, the American Petroleum Institute) to come in and say, "Regulation is expensive!" What isn't being asked is, "How expensive is de-regulation to the taxpayer?"

DR: Well, how do you propose that the taxpayer voice be heard?

MG: I was on the Hill when gasoline hit $40/gallon. People called, faxed, emailed and screamed at their members of Congress to do something. Right now the banks are faxing, meeting, voicing -- five lobbyists for every member of Congress! People who are listening who agree with what I'm saying and are worried should be on the phone, faxing and emailing your member of Congress and saying, "Please do what President Obama promised in writing and in his Wall Street speech. These instruments, without exception, should be regulated." What is happening is that Democratic members of Congress, I'm ashamed to say, [are saying] "These instruments are going to be regulated. Don't read the fine print!" And the fine print says, "No regulation."

DR: What do you think, Martin Baily?

MB: We live in a democracy. If people don't like what's done they should vote for someone else to change it. It's appropriate for banks to have a voice in what's going on. But it is appropriate that consumer groups also have a voice and they do have a voice.

DR: Enough of a voice, Greg Ip?

GI: Well, I think so. But you can often ask whether the voices that get heard are the right ones. For example, in our country we hate big banks and we like small ones. Small banks were hurt and that it why there is a very large exception in the consumer protection legislation for small banks.